Abaci's Common Sense Investing

From heaven - Xinyi Glass (868)

Xinyi was listed in Jan 2005 and is the largest exporter of auto glass in China. It sells mostly to the replacement market worldwide but is qualified to supply auto glass to all 3 major US carmakers, a proof of its product quality. Auto glass is not a flashy business but an essential one with consistent demand. You're not gonna change your windshield unless it's broken; and you're gonna have to change your windshield to stay on the road if it's broken. Auto glass took up 3/4 of the turnover and the remaining 1/4 is from construction glass, coated one which is said to be more environmental friendly and energy saving. Local and overseas sales mix is 60/40.

Xinyi fits into the growth story of both auto parts outsourcing and booming property market in China. The storyline is further enriched by the growing China automobile industry and the huge infrastructure spending under the eleventh-5-year plan. Xinyi's capitalization has doubled to about $6b in two years since the IPO. Profits were $260m in 2005 and $236m in 2004. 2006 interim profit was $140m. Turnover too grew from $1b in 2004 to $1.4b in 2005; 6-month turnover grew from $600m in 2005 to $700m in 2006.

Xinyi has production facilities in HK, Shenzhen, Donguan, and Wuhu. In the prospectus it said it'd spend $700m in installing two float glass production lines in its DG plant with maximum capacities of 269k tonnes and 157k tonnes. Float glass is the single largest cost component which takes up 1/2 of production cost. This backward integration is supposed to create substantial cost savings to Xinyi, first in terms of procurement and second in transportation. As I could tell this was the largest selling point of the IPO - no need to find customers to fill up this capacity and a 10% return on assets would produce $70m profit. However, no estimate of savings were made in the prospectus and it got few mentioning in the 2005 annual report. These float glass production lines were to begin commercial production in end of 2005 but according to the 2006 interim report, there's only trial production run and float glass sales was only 2% of turnover. I'd soon learnt about the over-supply problem in float glass from studying the glass company from hell, though some recent press reported that float glass price is finally rebounding. My concern is whether this delay is caused by teething problem, which will go away soon, or a larger quality issue (otherwise why not produce as much as possible since Xinyi needs float glass and has sunk in so much cost?). It remains to be seen how much benefit this $700m investment will yield.

Separately, Xinyi chose to expand into alternative energy (there's no previous mentioning in the prospectus) and announced in May last year it'd build a $290m solar glass plant in DG. Trial production would begin in 4Q 2007, sounds familiar? Two weeks later, Xinyi placed 220m shares via its sponsor Kingsway and raised $186m. Its ability and expertise in producing solar glass aside, Xinyi certainly seems to know how the keep the market's hope alive.

Xinyi's gearing has been decreasing and is now at <20%, which contrasts with the rapid expansion which saw it assets grew from $1.6b pre-IPO to $2.8b. Is it a lack of confidence in the expansion (therefore relying on OPM) or is the management just being conservative? Dividend policy is also puzzling. It paid out $190m dividends since the IPO but had to raise $186m from placing. It paid out 46% of earnings in 2005 but capax was 3x the earnings. Effective tax rate is unusually low at only ~5%.

Xinyi is run by Lee, a Fukienese, and family members - brothers, brothers-in-law, and sons. They hold some 50% shares in total. Market rumours had it that Kingboard bought some shares from the Lees who reported a sell down of 54m shares off the exchange in last November. This may add some credibillity to Xinyi but there's no way to confirm the news.

I like the auto glass business and the backward integration. I'm not sure about the solar glass part and hesitant about the management as they seem opportunistic and not very forefront in their presentation of the business. But it may just be my own suspicion. Say if Xinyi earned $300m in 2006 then the p/e would be 20x. Assuming $100m cost savings in 2007, the p/e will become more affordable though still not a bargain at 15x. The current price has probably taken into account of the savings from the float glass production as the existing plants are operating near full capacity and profit growth in 2005 already slowed down to 10%. But this area is also the biggest uncertainty.

I don't think Xinyi is my saving angel yet.

DISCLOSURE: I don't hold 868 at time of writing.